Can a Rental Property Be Part of a Retirement Portfolio?

by Steve Lander

Rental property is one way to build a nest egg.

If you want to build a stable retirement portfolio, you should diversify by putting your money into different types of assets. Investing in mutual funds instead of stocks is a good start, while adding bonds and real estate can provide even more diversification. Rental property fits particularly well in a retirement portfolio if you have a plan to manage its unique demands over the long term.

Long-Term Returns

With a rental property, you make money in three ways: First, you should receive monthly profit after collecting rents and collecting expenses. Next, the value of the property should grow over time, creating equity for you. Finally, you create further equity by paying down your mortgage. Moreover, if you renovate a rental property, you can create even more equity.

Inflation Indexing

Inflation can rob your savings of their value. While some investment vehicles, like money in the bank, typically lose value in times of inflation, others, like real estate, do well when money loses its value. Real estate is a great hedge against inflation for two reasons: First, when inflation becomes an issue, you can frequently compensate for it by raising your rents. Second, since people use money to buy real estate and inflation means that money is worth less, the price of real estate usually moves up to compensate for inflation. After all, while you can print more money, you usually can't make more land.

Favorable Tax Treatment

Real estate is especially valuable in a retirement portfolio because it gets special tax treatment even without having to put it in a special tax-advantaged account like a 401(k) or an IRA. With real estate, your equity grows without you having to pay tax until you sell it. If you sell your rental property and use your profits to buy more rental property, you can even defer paying your capital gains tax by doing a tax-deferred exchange. Your income from the property is also usually protected from some tax by additional write-offs that the IRS allows you to claim. All of these make it possible for you to own rental property outside your tax-advantaged accounts, letting you sock more money into them.

Rentals and Retirement

Rentals can be a great way to build your retirement portfolio, but you might not want to own them once you're retired. To really make rental properties work well, many investors choose to be very hands-on with them -- and this might not fit with your retirement lifestyle. If you do not want to be an active owner when you retire, you will either need to sell your rental properties then and reinvest the money in other asset classes, or do a tax-deferred exchange and buy easy-to-manage investment real estate properties that give you the same benefits of real estate ownership, but without the management. Alternatively, you could hire a property manager.

About the Author

Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.